There is an extensive and growing literature on the pedagogical effectiveness of simulation games in education (see Lean, Moizer, and Towler, 2006; Simkins, 1999; Motahar, 1994). The purpose of this note is to explain and illustrate how an economics simulation game can be used as an example and application of the monopolistic competition market to help in the teaching and learning of this market. A comprehensive guide on how to incorporate simulation games in business education at the college level is given by Gentry, et. Al. (1990).

Use in Standard Classroom or for Experimental Economics

A monopolistic competition simulation can be used as an example in the standard economics classroom or for experimental economics. Economic experiments using monopolistic competition simulations can create real-world incentives that may be used in the teaching and learning of economics to help students better understand why markets and other exchange systems work the way they do. A detailed explanation of experimental economics is given by Roth (1995).

An online computerized economic simulation game called “Beat the Market” is used to simulate several different examples of the monopolistic competition market. This simulation is designed to put students inside the theoretical world of monopolistic competition as described in the standard economics textbook. Through the simulation, students participate directly in the market by managing a simulated firm and making decisions on price and production to maximize profits.

Assumptions of Monopolistic Competition Simulation Game Example

All the example simulations follow the basic theoretical assumptions of the monopolistic competition market structure and include:

A large number of firms, at least 25.

Small firm size, starting market share of each firm about 4%.

Easy entry and exit, based on economic versus normal profits.

Product differentiation is possible but limited.

Options in Simulating the Monopolistic Competition Market

In the example simulations, the instructor may select different environments within the context of monopolistic competition, including:

Short-run versus long-run

Degree of product differentiation

Macroeconomic environment (stable, growth, cyclical)

Two simulation game examples will be illustrated, including one short-run and one long-run simulation. The example simulations illustrated here will hold the degree of product differentiation and the macroeconomic environment constant. (But the software does allow these variables, options 2 and 3 above, to be included at the discretion of the instructor.)

Short-run Monopolistic Competition Game Example Simulation

The short-run simulations do not allow students to change the plant size of their firm, but firms will still enter or exit the market if accounting profits differ from normal profit levels in the simulated monopolistic competition market.

Controllable Decisions in the Short-run Monopolistic Competition Simulation Game Example

Firm Price

Firm Production

Simulation Performance in Short-run Example

At the start, the market is not in equilibrium and has the following characteristics.

Quarter

Number of Firms

Market Price

Market Demand

Market Supply

Average Accounting Profit

0

25

$75.11

127,125

102,500

$119,522

Note that normal profits in this market are $100,000 and the average market profit is $119,522.

Students make decisions for their firms based on their own firm characteristics. In this market example, firms start with an excess demand. Students are given information on their firm costs and revenues, including marginal costs and marginal revenues. The knowledgeable students (and the numerous computer managed firms) begin by raising their prices and increasing the quantity supplied. No matter the decisions of any student managed firm, the overall behavior of the market is not influenced by any one student, since each firm is very small in size relative to the market. In quarter 1 in this example, average firm accounting profits increase, but through time the following expected results occur.

Short-run Simulation Results (Normal Profits $100,000)

Quarter

Number of Firms

Market Price

Market Demand

Market Supply

Average Accounting Profit

1

25

$78.56

110,480

110,400

$137,846

2

27

$76.96

118,271

118,508

$131,218

3

30

$74.71

129,167

131,224

$119,487

4

32

$73.02

137,328

139,484

$112,033

5

35

$70.89

147,551

150,227

$102,998

6

35

$70.04

151,632

152,417

$100,573

After quarter 1, new firms entered the market because accounting profits exceeded normal profit levels of $100,000 in this example. The number of firms increased from 25 in quarter 1 to 35 in quarter 5. No additional firms entered in quarter 6 because accounting profits were close to normal levels. The decrease in accounting profits occurred because the market price declined as new firms entered and the markets supply increased. The market stabilized after six quarters because economic profits were at, or close to, zero; and market demand was close to market supply.

Long-run Monopolistic Competition Simulation Example

The long-run simulation example allows students to change the plant size of their firm and take advantage of economies of scale. Both economies and diseconomies of scale exist in the simulation. Students are given information on how the average variable costs change in the simulation with increases in plant size. But again, as required in the model, firms will enter or exit the monopolistic competition market until economic profits return to zero.

Controllable Student Decisions in Long-run Simulation Example

In this example, plant size is added as a third controllable student decision, and now includes:

Firm price

Firm production

Firm plant size

Simulation Performance in Long-run Example

At the start, the market is not in equilibrium and has the following characteristics.

Quarter

Number of Firms

Average Plant Size

Market Price

Market Demand

Market Supply

Average Accounting Profit

0

25

6.0

$75.11

127,125

102,500

$119,522

Note that the starting characteristics of the market are set to be the same as in the short-run example. Normal profits are again $100,000. In this way comparisons can be made more directly between the two simulation examples. The major difference in the long-run example is that plant size may now be changed. As in the previous simulation example, all firms start with an excess demand, and their accounting profits are initially $119, 522, which are greater than normal profits. Given this starting scenario, students again begin by raising their prices and increasing the quantity supplied. But this time, plant size also increases as students take advantage of economies of scale that is built into this simulation example. Firm profits increase initially, but through time the following expected results occur.

Long-run Simulation Results (Normal Profits $100,000)

Quarter

Number of Firms

Average Plant Size

Market Price

Market Demand

Market Supply

Average Accounting Profit

1

25

6.0

$78.64

111,621

110,347

$137,243

2

27

7.4

$75.01

130,283

129,595

$141,475

3

30

9.0

$69.75

156,602

157,854

$133,859

4

33

10.7

$63.86

185,217

192,432

$117,176

5

36

11.4

$58.98

208,652

220,541

$ 98,669

6

36

11.6

$56.86

219,731

221,730

$ 99,870

These results had a number of similarities to the short-run example, but also some major differences. As in the short-run example, firms entered the market after quarter 1 because accounting profits exceeded normal profit levels of $100,000. The number of firms increased and the market stabilized after six quarters because economic profits were at, or close to, zero; and market demand was close to market supply.

But in the long-run simulation example there were several important differences.

Plant size increased significantly since it was a controllable decision of the firm and there were economies of scale.

Economies of scale meant firms were able to take advantage of lower average costs and initially earn higher profits (before entry of new firms).

Market price was bid down much lower than in the short-run example because firms were able to lower their average costs of production, and firms continued to enter the market as long as economic profits existed.

Even though firms were able to reduce costs through economies of scale, they were not able to maintain profits above normal levels in the long-run.

Concluding Remarks

From an educational point of view, the benefit of a simulation game example is that students will have an “opportunity” to learn by their own observations and experience. In these simulation examples, student participants would observe and experience that their pricing decisions are controlled by the market. They would “experience” that in the simulation they would have to lower their firm’s price to be competitive as new firms entered the market. In the long-run simulation example, they would see the impact of changing plant size. They would observe that the successful firms would take advantage of economies of scale, but would also be careful not to incur diseconomies of scale in the long-run. Students would see the benefits of economies of scale in reducing costs and increasing profits, but experience that economic profits cannot be maintained in the long-run. They would observe, first hand, that their accounting profits will inevitably decline and move closer to normal profits. While participating in the simulation, students would experience the same dilemmas and frustrations that firm owners face in the real world. This experience provides students another opportunity to learn (as a supplement to the lecture and readings) the economic messages of monopolistic competition.